Should You Do a Roth Conversion? Here's How to Think About It

If you've got money sitting in a traditional IRA or 401(k), you've probably heard the term "Roth conversion" tossed around. Maybe your CPA mentioned it. Maybe a friend did one and won't stop talking about it. So what actually is it, and is it something you should be thinking about?

Let's break it down in plain English.

What Is a Roth Conversion?

A Roth conversion is when you move money from a traditional retirement account (like an IRA or old 401k) into a Roth IRA. The catch is that you have to pay income tax on the amount you convert in the year you convert it. Once that money is in the Roth, it grows tax-free, and you never pay taxes on it again, as long as you follow the withdrawal rules.

Think of it like this: with a traditional account, you're saving on taxes now, but you'll owe Uncle Sam later. With a Roth, you pay the taxes now so the growth and future withdrawals are yours to keep, free and clear.

It's not free money. It's a trade. You're choosing to pay tax today instead of tomorrow, and the whole question is whether that trade is worth it for your situation.

Who Might Benefit From a Roth Conversion?

Roth conversions tend to make the most sense for people who:

• Are in a lower tax bracket right now than they expect to be later. This happens a lot in the gap years between retiring and starting Social Security or Required Minimum Distributions (RMDs), when income can dip for a few years.
• Have money outside their retirement accounts to pay the conversion tax bill. If you have to pull the tax payment from the IRA itself, it eats into the benefit and can trigger a penalty if you're under 59½.
• Want to leave tax-free money to their beneficiaries. Roth IRAs are especially valuable for heirs who aren't a spouse, since many of them now have to empty the account within 10 years of inheriting it. Getting an income tax-free 10 years is a lot better than a taxable one.
• Don't need the money for retirement income anytime soon. Roth IRAs have no RMDs during your lifetime, so the money can keep growing tax-free for as long as you let it sit.

On the flip side, if your retirement accounts are earmarked for qualified charities when you pass, a Roth conversion usually doesn't make sense. Charities don't pay income tax either way, so there's nothing to gain and a tax bill to lose in the meantime.

When Does It Make Sense to Plan For (and Actually Do) a Conversion?

This is where a lot of people get it backwards. A Roth conversion isn't a "set it and forget it" decision. It's something to revisit every year, because the right amount to convert depends on where your income lands that specific year.

Good years to consider converting often include:

• The early years of retirement, before Social Security and RMDs kick in and push your income back up
• A year where your income is unusually low, maybe from a job change, a business slowdown, or taking time off
• A year the market has dropped, since you're converting shares at a lower value and paying less tax to convert the same number of shares
• Before tax rates are scheduled to go up, if you're confident your future rate will be higher than today's

The "how much" question matters just as much as the "when." Convert too little and you're leaving an opportunity on the table. Convert too much and you can accidentally push yourself into a higher tax bracket, or trigger higher Medicare premiums (IRMAA), reduce a financial aid award, or shrink an ACA subsidy. This is why Roth conversions really shouldn't be a DIY, guess-and-check project. It takes some modeling to find the sweet spot.

Are There Reasons NOT to Do a Roth Conversion?

Yes, and this is just as important as knowing when it's a good idea.

• You expect to be in the same or a lower tax bracket in retirement. If that's the case, paying tax now doesn't buy you much.
• You don't have outside cash to cover the tax bill. Using retirement funds to pay the tax reduces your nest egg and can trigger an early withdrawal penalty.
• You'll need that money within five years. Each conversion has its own five-year clock before it can come out penalty-free, so timing matters if you might need access to the funds sooner.
• A conversion would bump you into income-based program limits. Medicare IRMAA surcharges, financial aid, and ACA subsidies are all based on income, and a large conversion can quietly cost you more than the tax savings are worth.
• Your beneficiaries are in a low tax bracket. If your heirs will pay very little tax on an inherited traditional IRA anyway, there's less reason to pay it for them now.

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The Bottom Line

A Roth conversion can be one of the smartest tax moves available to you, or it can be an expensive mistake, depending entirely on your specific numbers and timing. It's not something we do once and check off a list. It's a strategy we revisit year by year, looking at your income, your tax bracket, your goals for your family, and what's happening with tax law.

If you've been wondering whether this year is a good year for you to convert, that's exactly the kind of conversation worth having before December 31st rolls around. Reach out and we can look at your numbers together.

Tax information is provided to aid in discussion and for educational purposes only. Planning for Good and Cambridge do not offer tax advice. Please consult with a qualified tax professional for specific recommendations regarding your situation.